How to Choose the Right Business Vehicle

Updated June 2012

This How-To Brief outlines steps to take in helping clients choose the right business vehicle for their enterprise under Ontario and applicable federal legislation. While there are other forms of business organizations that may best suit your client's needs, the following will focus on the four commonly used business vehicles: sole proprietorships, partnerships, limited partnerships and corporations. Where applicable, you should consider other forms of business organizations with your client such as franchises, co-operatives and joint ventures.

1Discuss the nature and scope of your client's business

Before it is possible to ascertain which form of business vehicle may best suit your client's needs, it is important to first learn as much as possible about the nature of your client's business:

  • Determine whether the business is a going concern or start-up operation.
  • Inquire into the nature and fundamentals of the business.
  • Review your client's goals and plans for the operation (both current and on a going-forward basis).
  • Assess your client's desire for personal control over the enterprise.
  • Determine whether your client is or plans to be sharing the management and participation of profits derived from the business with others.
  • Gauge your client's desire for employee participation in the growth and profits of the business enterprise.
  • Discuss your client's tolerance to costs and regulatory scrutiny.
  • Determine in which jurisdictions your client wishes to operate.

See the Government of Canada's "Forms of Business Organization" website in the Resources section of this How-To Brief for a helpful government fact sheet on business forms including advantages and disadvantages of each.

See also the Resources section of this How-To Brief for links to the following websites and resources:

  • Government of Canada, Starting a Business
  • Government of Ontario, Business Resources
  • Business Development Bank of Canada
  • Corporation Centre, Incorporation Resources

2Discuss liability issues particular to each form of business vehicle


  1. Review the level of risk associated with your client's business:
    1. What kind of risk exposure does your client face?
    2. What is the likelihood of being sued in the ordinary course of business?
    3. How risk averse is your client?
    4. What degree of participation in, and assumption of, financial risk by each proprietor does your client desire? (where applicable)
    5. Can insurance mitigate risk exposure?
     
  2. Explain how liability is treated under each form of business vehicle:
    1. Sole proprietorship: Liability under this business vehicle is unlimited. There is no legal distinction between the business assets and personal assets of the proprietor. All assets of the sole proprietor may be seized in fulfillment of the business's obligations. Sole proprietors are personally responsible for performing all contracts entered into in the course of the business and all torts committed personally in connection with the business. They also face vicarious liability claims for all torts committed by employees in the ordinary course of their employment.
    2. Partnership: Like a sole proprietorship, a partnership is not a legal entity separate from its partners. The assets and liabilities of the partnership are considered the assets and liabilities of the partners themselves. Each partner is jointly liable with the other partners for all debts and obligations of the partnership incurred while the person is a partner. This liability continues after the partner’s death as the partner’s estate becomes severally liable in a due course of administration for such debts and obligations so far as they remain unsatisfied, but subject to the prior payment of his or her separate debts. This liability extends to contractual obligations agreed to by any partner in the normal course of business, even if the entire partnership base did not consent to the obligation. Partners are joint and severally liable for any wrongful acts or omissions of a partner acting in the normal course of the business. This unlimited personal liability of a partner is an important issue to consider. Partners must have a certain degree of trust in each other. While many rules of the Partnerships Act may be amended by a partnership agreement, liabilities in relation to third parties cannot be altered. (Partnerships Act, ss. 6 and 10–13)
    3. Limited partnership: This form of business arrangement involves a partnership between at least one limited partner and at least one general partner. Liability of the limited partners is limited solely to what they invest, or have agreed to invest, in the partnership, but they must abstain from taking part in control of the business. On the other hand, the general partner faces unlimited liability but is vested with decision-making authority over the business. This risk exposure can generally be mitigated by the general partner’s use of a corporation. (Limited Partnerships Act, ss. 2(2), 13(1) and 9)
    4. Incorporation: A corporation is a legal entity that is separate from its owners, the shareholders. Therefore, as a general rule, no shareholder of a corporation is personally liable for the debts, obligations or acts of the corporation. It is the corporation alone that is responsible for the obligations of the business it carries on. Consequently, a shareholder's maximum potential loss is limited to the equity he or she has contributed to the corporation. Directors, officers and agents of the corporation can, however, bear some liability for their acts on behalf of the corporation. (Business Corporations Act, ss. 130–131 and 134)
     

See the Resources section of this How-To Brief for links to the following websites and resources:

  • Partnerships Act
  • Limited Partnerships Act
  • Business Corporations Act
  • Sample partnership agreement

3Discuss ownership and control of the business

A key consideration in determining which form of business vehicle best suits your client's needs is the level of control and ownership he or she desires to have over the business both now and into the future.

  1. Sole proprietorship: A sole proprietorship cannot be carried on by more than one person. Accordingly, as sole owner of the business, the sole proprietor is in direct control over the decision-making and management of the business.
  2. Partnership: Ownership and control in an ordinary partnership is initially defined in the default rules under the Partnerships Act. However, in most cases, these rules are contractually altered by the partners in the form of a partnership agreement to better reflect their respective interests in the partnership. Partnerships are flexible in that the management responsibilities of the partnership business can be divided among the partners in virtually any way the partners agree. In the absence of a specific agreement, each partner has an equal right to take part in the management of the partnership's business. (Partnerships Act, ss. 24.5)
  3. Limited partnership: In a limited partnership, the general partner has all of the rights and obligations of a partner in an ordinary partnership (including the right to manage the business) subject to the provisions of s. 8 of the Limited Partnerships Act,which requires the consent of the limited partners for certain specified acts. While a limited partner may inquire into the state and progress of the partnership business and advise as to its management, he or she may not take part in the control of the business. Taking an active role in the management of the partnership or even allowing one's name to be used in the firm name will cause the limited partner to lose his or her limited liability status and be subjected to the unlimited liability exposure of a general partner. (Limited Partnerships Act, ss. 6(2), 7(1), 8, 12(2) and 13(1))
  4. Incorporation: In a corporation, the directors have the responsibility to manage or supervise the management of the business and affairs of the corporation. Officers, in contrast, are appointed by the board and exercise the powers delegated to them by the directors. Finally, shareholders retain the power to vote for the election of directors, on certain fundamental changes and events and on proposals made to or by them. In closely held private corporations, shareholders can also leverage their control of the business by usurping the power of the directors through a unanimous shareholders agreement. (Business Corporations Act, ss. 108, 115, 133 and 168–186)

See the Resources section of this How-To Brief for links to the following websites and resources:

  • Partnerships Act  
  • Limited Partnerships Act  
  • Business Corporations Act  
  • Sample partnership agreement
  • Sample unanimous shareholder agreement

4Discuss current and anticipated returns on investment and financing requirements

Your client's capital requirements and expected returns from the business will largely determine which form of business vehicle is ideal both now and into the future. Where the business is a start-up operation with minimal complexities, it may make most sense to begin as a sole proprietorship and then transition later into an incorporated entity as the scale of the business grows.

  1. Sole proprietorship: The sole proprietor is entitled to all profits and is responsible for all losses from the business. Returns can be channelled back into the business or taken as profit in full. Available capital is limited to the sole proprietor’s assets and the extent of his or her credit. Obtaining debt financing may be a challenge especially for sole proprietors who do not have sufficient assets to secure a loan. As a result, the business activities of sole proprietors are often limited, at least initially, to operations with low capital requirements. Given these constraints, sole proprietors may have to explore the possibilities of other business structures in order to raise necessary capital.
  2. Partnership: A partnership structure facilitates the pooling of diverse skills, expertise and capital through the combination of various owners with a common view to profit. The increase in the number of owners provides greater access to equity funds. Debt financing can also be easier to obtain as lenders can look to the assets of several partners. However, like a sole proprietorship, it will ultimately be the creditworthiness of the partners that determines the creditworthiness of the business.

    The default rule for return on investment under the Partnerships Act is an equal sharing of capital and profits and equal contribution resulting from losses. However, this rule can be amended by agreement between the partners, express or implied, to better reflect more proportionate returns based upon each partner's contribution to the partnership. (Partnerships Act, s. 24)
  3. Limited partnership: A limited partnership facilitates the raising of equity capital by attracting passive investors that are interested in a return from the business without the unlimited liability or management responsibility associated with an ordinary partnership. Obtaining debt financing may remain a challenge given that only the general partner(s) is exposed to unlimited liability. However, like a sole proprietorship and ordinary partnership, the ability to obtain debt is likely to depend on the sufficiency of assets that the lenders have recourse to rather than the type of business vehicle used.

    Under the Limited Partnerships Act, limited partners share in the profit in relation to their respective contribution of money or other property to the limited partnership, subject to any variation in a partnership agreement. (Limited Partnerships Act, s. 14)
  4. Incorporation: Similar to a limited partnership, an incorporated business appeals to a larger base of investors by offering shareholders limited liability together with an ownership interest in the business. Various classes of shares can be created, and tailoring the privileges attaching to each class can appeal to diverse investor preferences and facilitate greater opportunities for investment in a business. Corporations also offer investors the ability to retain the right to participate in the decision-making process of the enterprise through the voting privileges attached to their respective shares. As a separate legal entity, a corporation owns its own property, and creditors may look to the assets of the business in order to secure loans rather than merely to the personal assets of the sole proprietor or partner in a partnership. As practical matter, however, loan transactions involving small businesses will often require a personal guarantee from a shareholder or director effectively removing the benefit of limited liability.

    Shareholders share in the profits of the corporation when the corporation makes a distribution to them in the form of dividends. Subject to the company's articles and any unanimous shareholder agreement, the power to declare dividends rests with the directors. Under the Business Corporations Act, dividends may be paid in cash when there are no reasonable grounds for believing that the payment of a dividend will render the corporation insolvent. (Business Corporations Act, s. 38)

See the Resources section of this How-To Brief for links to the following websites and resources:

  • Partnerships Act  
  • Limited Partnerships Act  
  • Business Corporations Act  
  • Government of Ontario, Financing for Starting a Business Info-Guide
  • Industry Canada, Sources of Financing
  • Small Business Finance Centre

5Discuss tax, transferability and estate planning considerations

Determine the level of profitability your client's operation currently yields or whether losses are expected in the start-up years of the business. Explore whether your client has other sources of income that could be sheltered with the losses generated by a flow-through business vehicle as discussed below.

  1. Sole proprietorship: There is no legal difference between a sole proprietorship and the individual running it, with the result that the sole proprietor is directly taxed on the income or losses of the sole proprietorship. This allows losses from the business to be applied against income from other sources. On the other hand, in profitable years, the income from the business will generally be taxed at higher tax rates than those applicable to corporations.

    Transferability and estate planning considerations are simplified under this form of business vehicle since the business will dissolve upon the death of the sole proprietor unless otherwise sold or transferred through inheritance.
  2. Partnership: Although income and losses are calculated at the partnership level, the partnership itself is not subject to tax. Instead, the income or loss of the partnership is allocated to, and taxed in the hands of, each individual partner according to the agreed-upon allocation of partnership interests (tax is incurred whether or not the partnership has actually distributed a partner's share to the partner yet). Because new businesses frequently experience losses, the flow-through tax treatment of this business vehicle, much like the sole proprietorship, can often benefit partners by allowing them to immediately apply any losses from the business to offset income from other sources.

    Transferability and estate planning matters are limited under this business vehicle since most partnership agreements restrict partners' rights to withdraw from the partnership or to transfer their respective ownership interests. Since a partnership is not a legal entity separate and apart from its partners, it is inherently fragile. Unless the partners agree otherwise, the partnership will be terminated upon the death or insolvency of any partner. (Partnerships Act, s. 33(1))
  3. Limited partnership: Like an ordinary partnership, allocated losses from a limited partnership may be applied against a partner's income from other sources with the effect of reducing the partner's overall tax liability. However, in the case of limited partnerships, there are additional technical tax rules that may limit the application of such losses under certain circumstances.

    Limited partners are not agents of the limited partnership, and one's death, bankruptcy or incapacity will not terminate the limited partnership (subject to the rule that there must always be at least one limited partner). A limited partner's interest is transferable, but in order for the transferee to acquire the full rights of the transferor, unanimous consent of all partners is required unless authorization is otherwise given in the partnership agreement. (Limited Partnerships Act, s. 18)

    The retirement, death or incapacity of a general partner, or a corporate general partner's dissolution, dissolves a limited partnership. However, if there are remaining general partners, the business may continue if the right to do so is given in a partnership agreement and with the consent of all remaining partners. (Limited Partnerships Act, s. 21)
  4. Incorporation: Because corporations constitute a separate legal entity from their owners, they are the only form of business vehicle that is taxed at the company level. This can be disadvantageous for some investors since it precludes the flow-through possibilities available in both partnerships and sole proprietorships and can also lead to double taxation when profits are distributed to shareholders by way of dividends. On the other hand, if the business is expected to be profitable and it is expected that cash will be retained in the corporation for ongoing use in the business (rather than distributed to the shareholders), corporate tax rates are generally lower than the tax rates that would be applicable to individuals who are partners or sole proprietors.

    Since a corporation is a separate legal entity, it has a perpetual existence notwithstanding the death or withdrawal of a shareholder or director. Shareholders own the corporation through their ownership of shares, which are readily transferable. Transferability of ownership can be controlled, however, by placing restrictions on the transfer of shares in the share terms of the company's articles or through a shareholder agreement. Tailored share terms may also enable a proprietor to maintain control over the business while allowing equity growth to accrue to successive generations.

See the Resources section of this How-To Brief for links to the following websites and resources:

  • Partnerships Act
  • Limited Partnerships Act
  • Sample shareholder agreement
  • Taxation Info-Guide
  • Canada Revenue Agency, Corporations

Resources

Statutes